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me/UPSCFRATERNITY 1
TABLE OF CONTENTS
TABLE OF CONTENTS.................................................................................................. 1
1. Definition of Inflation....................................................................................................2
2. Measurement of Inflation.............................................................................................2
3. Causes of Inflation.......................................................................................................2
4. Impacts of Inflation...................................................................................................... 3
National Impact...........................................................................................................3
International Impact.................................................................................................... 3
5. Important Concepts Related to Inflation...................................................................... 4
6. Recent Trends and Examples..................................................................................... 4
7. Different Measures to control Inflation.........................................................................4
1. Monetary Measures (Control by RBI)..................................................................... 4
2. Fiscal Measures (Control by Government)............................................................. 5
3. Structural Measures (Long-term Measures)........................................................... 6
Monetary Policy Framework in India:.............................................................................. 7
Challenges in Controlling Inflation in India...................................................................... 7
Difference B/W CPI and WPI.......................................................................................... 7
Types of Consumer Price Indices (CPI).......................................................................... 8
Expansionary vs Contractionary Monetary Policy........................................................... 8
Impact of Inflation on Balance of Payments (BoP) in India........................................... 10
Currency Depreciation, Appreciation, Devaluation, and Revaluation with Impacts on
different Economic Parameters..................................................................................... 11
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1. Definition of Inflation
● Inflation refers to the persistent rise in the general price level of goods and services in an economy
over a period of time, typically measured annually.
Types of Inflation
Type of Inflation Description Rate of Increase
Creeping Inflation Slow and moderate increase in prices 0-5% per year
Walking Inflation Moderate inflation, generally seen 5-10% per year
during periods of healthy growth
Galloping Inflation Rapid inflation, often seen during 10-50% per year
periods of instability or crises
Hyperinflation Extremely high and accelerating >50% per month
inflation, typically leading to currency
collapse
2. Measurement of Inflation
Index Description Used For
Consumer Price Index (CPI) Measures price changes of Measuring cost of living
goods/services typically consumed by
households
Core CPI Excludes food and energy prices to Capturing long-term trends
measure underlying inflation trends
Headline Inflation Headline inflation provides a Capturing short-term trends
comprehensive look at price
increases in an economy.
Wholesale Price Index (WPI) Measures price changes at the Used for producer-level inflation
wholesale level, excludes services
GDP Deflator Reflects price changes of all goods Measuring price level changes for the
and services produced in the entire economy
economy
3. Causes of Inflation
Type Cause Examples
Demand-Pull Inflation Aggregate demand exceeds Economic recovery, fiscal stimulus,
aggregate supply consumer confidence
Cost-Push Inflation Increased production costs raise Rising oil prices, higher wages, supply
prices chain disruptions
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Built-in Inflation Workers demand higher wages due to Wage-price spiral
rising living costs, pushing up
business prices.
Imported Inflation Rising costs of imports due to Falling rupee increases oil prices
currency depreciation or global price
hikes.
Monetary Factors Increase in money supply beyond Hyperinflation in
economic growth. Zimbabwe/Venezuela
Structural Inflation This type is related to long-term shifts in industries, technological
changes in the economy. changes, or demographic changes
4. Impacts of Inflation
National Impact
Impact Description Stakeholders Affected
Purchasing Power Erosion Inflation reduces the real value of Lower-income households,
money, leading to decreased fixed-income earners
purchasing power
Interest Rates and Borrowing Rising inflation leads to higher Borrowers (e.g., home loan holders)
nominal interest rates, making
borrowing more expensive
Wage-Price Spiral Higher wages lead to higher business Workers demanding higher wages,
costs, further increasing prices businesses
Investment and Savings Inflation erodes savings, discourages Savers, investors
long-term investments
Income Redistribution Debtors benefit, while creditors lose Creditors vs. Debtors, fixed income
value on loans groups
Government Finances Inflation increases tax revenue but Government (higher fiscal deficits)
also raises government spending
International Impact
Impact Description Example
Currency Depreciation Inflation reduces the value of Depreciation of the Indian Rupee
domestic currency, increasing import
costs
Competitiveness Inflation reduces export Indian goods losing price advantage
competitiveness as goods become
more expensive for foreign buyers
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Global Price Shocks Inflation in one country can impact Oil price shock due to geopolitical
global commodity prices and affect events (e.g., Russia-Ukraine war)
other economies
5. Important Concepts Related to Inflation
Concept Description Example
Hyperinflation Extremely high inflation, often Zimbabwe's 2008 hyperinflation
exceeding 50% per month
Stagflation High inflation, stagnant growth, and Global economy during the 1970s oil
high unemployment crisis
Disinflation Reduction in the rate of inflation A country reducing inflation from 10%
(prices still rise but at a slower pace) to 6%
Deflation A decrease in the general price level The Great Depression of the 1930s
of goods and services
6. Recent Trends and Examples
Period Inflation Trend Impact
2010-2014 High inflation in India, especially in Strained household budgets, RBI's
food and fuel prices action to control inflation
Post-COVID (2020-2022) Surge in inflation due to supply chain Central banks globally raise interest
disruptions, rising commodity prices rates to control inflation
Global Inflation (1970s Oil Crisis) Global oil price hikes leading to Inflation spike globally, especially in
widespread inflation oil-importing countries
Global Inflation (2021-2022) Post-pandemic recovery and the Global price rise, especially in energy
Russia-Ukraine conflict lead to and food sectors
inflation spikes
7. Different Measures to control Inflation
1. Monetary Measures (Control by RBI)
Monetary policy is primarily used to control demand-pull inflation (caused by excessive demand) and
cost-push inflation (caused by increased production costs).
Monetary Explanation
Measure
Repo Rate The rate at which RBI lends to commercial banks. Increasing the repo rate raises
borrowing costs, reduces liquidity, and curbs inflation.
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Reverse Repo The rate at which RBI borrows from commercial banks. Increasing the reverse repo
Rate rate encourages banks to park excess funds with RBI, thus reducing money supply
in the economy.
Cash Reserve The percentage of a bank's total deposits that it must keep with the RBI. Increasing
Ratio (CRR) the CRR reduces the funds available for lending, thus reducing inflationary
pressures.
Statutory The minimum percentage of commercial banks' net demand and time liabilities that
Liquidity Ratio they must keep in liquid assets. Increasing the SLR restricts the money available for
(SLR) loans, reducing inflation.
Open Market RBI buys or sells government securities to control money supply. Selling securities
Operations absorbs excess liquidity, thus controlling inflation.
(OMOs)
Marginal A window for commercial banks to borrow from RBI in case of emergency.
Standing Increasing MSF rate discourages borrowing and reduces inflationary pressures.
Facility (MSF)
Currency RBI may manage the money supply by issuing or withdrawing currency to control
Management excessive liquidity.
Forward Communicating RBI's future monetary policy intentions can influence expectations
Guidance and consumption patterns, which helps control inflation.
2. Fiscal Measures (Control by Government)
Fiscal policy addresses inflation through taxation, public expenditure, and subsidy management to
influence aggregate demand and supply.
Fiscal Measure Explanation
Increasing Higher direct taxes (like income tax) and indirect taxes (like GST) reduce
Taxes disposable income, thus lowering consumption and curbing demand-pull inflation.
Reducing Cutting or rationalizing subsidies on items like fuel and food reduces government
Subsidies expenditure and demand, controlling inflationary pressures.
Controlling Reducing unproductive government spending (e.g., on non-essential public
Government projects) ensures that demand does not outpace supply, helping control inflation.
Expenditure
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Public Reducing government borrowing from the market prevents excessive money
Borrowing supply. Excessive borrowing can lead to an increase in inflation.
Monetary-Fiscal Coordination between the RBI and the Government ensures that fiscal policy
Coordination (expenditure and taxation) and monetary policy (interest rates) work together to
control inflation effectively.
Import Imposing tariffs and restrictions on imports can reduce the pressure from rising
Restrictions global prices, particularly in essential commodities like oil, helping control inflation.
Price Controls In extreme cases, the government may set price ceilings on essential goods or
and Regulation introduce rationing systems to control inflation, particularly during shortages (e.g.,
food grains, fuel).
3. Structural Measures (Long-term Measures)
In addition to short-term monetary and fiscal measures, structural reforms can help control inflation in the
long run:
Structural Explanation
Measure
Improving Increasing food production through investment in agriculture (e.g., irrigation,
Agricultural technology) reduces food price inflation.
Productivity
Enhancing Supply Improving infrastructure (e.g., transport, storage) reduces supply bottlenecks and
Chain Efficiency cost-push inflation.
Trade Policy Liberalizing trade and reducing barriers to imports can help lower prices,
Reforms especially of essential goods like fuel and food.
Promoting Encouraging competition in markets, particularly for essential goods, reduces
Competition monopolistic pricing, helping lower inflation.
Financial Inclusion Improving access to credit and financial services reduces economic disparities,
which can help reduce inflationary pressures from demand in specific sectors.
Monetary Policy Framework in India:
● Inflation Targeting: Since 2016, the Reserve Bank of India (RBI) has followed a flexible inflation targeting
framework with a target range of 4% ± 2% based on the Consumer Price Index (CPI).
○ The Monetary Policy Committee (MPC), consisting of six members, meets bi-monthly to set the repo
-rate and other monetary policy measures.
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Challenges in Controlling Inflation in India
Challenge Explanation
Supply-Side Shortages in food, energy, and raw materials can lead to cost-push
Constraints inflation.
Global Factors International commodity prices, especially crude oil, heavily influence
inflation in India.
Monetary Policy The impact of changes in interest rates or money supply takes time to
Lags affect inflation.
Political Government subsidies and price controls can sometimes lead to
Pressure inflationary pre
Difference B/W CPI and WPI
Feature Consumer Price Index (CPI) Wholesale Price Index (WPI)
Purpose Measures price changes for goods & services Measures price changes for goods at
consumed by households the wholesale level
Coverage Retail prices of consumer goods and services Prices of goods traded between
wholesalers or producers
Components Food, housing, transport, healthcare, education, Primary articles, fuel & power,
etc. manufactured goods
Base Year 2012 (currently in India) 2011-12 (currently in India)
Use Inflation targeting, cost of living adjustments Producer-level inflation monitoring
Price Level Retail (consumer level) Wholesale (producer level)
Indicative of Inflation faced by consumers Inflation at the production or
wholesale level
Calculated by Central Statistics Office (NSO), Ministry of Office of Economic Adviser, Ministry
Statistics & Programme Implementation of Commerce & Industry
Frequency of Monthly (published by NSO) Monthly (published by Ministry of
Release Commerce)
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Types of Consumer Price Indices (CPI)
CPI Type Base Compiled By Coverage Use
Year
CPI for Industrial 2016 Labour Bureau Industrial workers in Tracks inflation for
Workers (IW) (Ministry of Labour) sectors like factories, manual workers; used for
mines, plantations, wage adjustment
railways, etc.
CPI for 1986- Labour Bureau Agricultural labourers Monitors inflation for
Agricultural 87 (Ministry of Labour) working in rural areas agricultural workers in
Labourers (AL) rural areas
CPI for Rural 1984- Labour Bureau Rural labourers in both Monitors inflation for rural
Labourers (RL) 85 (Ministry of Labour) agricultural and manual workers
non-agricultural sectors
CPI for Urban 1984- Central Statistical Urban non-manual Used for adjusting
Non-Manual 85 Organisation (CSO), employees (e.g., office Dearness Allowance and
Employees Ministry of Statistics workers) computing capital gains
(UNME)(Disconti tax
nued since2008)
CPI for 2012 Central Statistical Combined coverage of Measures overall inflation
Rural-Urban Organisation (CSO), rural and urban for both rural and urban
Combined Ministry of Statistics populations households
Expansionary vs Contractionary Monetary Policy
Aspect Expansionary Monetary Policy Contractionary Monetary Policy
Objective To increase money supply and reduce To reduce money supply and increase
interest rates to stimulate economic activity. interest rates to control inflation.
When is it Used during periods of economic slowdown, Used during periods of high inflation or
used? recession, or deflation to encourage economic overheating to cool down the
investment and consumption. economy.
Important 1. Reduction in Repo Rate 1. Increase in Repo Rate
Measures
2. Reduction in Reverse Repo Rate 2. Increase in Reverse Repo Rate
3. Lowering Cash Reserve Ratio (CRR) 3. Increase in Cash Reserve Ratio
(CRR)
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4. Lowering Statutory Liquidity Ratio (SLR) 4. Increase in Statutory Liquidity Ratio
(SLR)
5. Open Market Operations (OMOs) - Buying 5. Open Market Operations (OMOs) -
government bonds to increase liquidity. Selling government bonds to reduce
liquidity.
Effect on Increases money supply, making borrowing Decreases money supply, making
Money cheaper and encouraging spending and borrowing more expensive and reducing
Supply investment. inflationary pressures.
Impact on Reduces interest rates, encouraging loans Raises interest rates, discouraging
Interest and investments. excessive borrowing and spending.
Rates
Impact on Can increase inflation if demand outpaces Reduces inflation by cooling down
Inflation supply due to higher spending. demand and reducing excessive price
increases.
Effect on Depreciates the currency (may lead to higher Appreciates the currency (may lead to
Currency exports). lower exports).
Tools 1. Lowering repo and reverse repo rates 1. Increasing repo and reverse repo
Used rates
2. Reducing CRR and SLR 2. Increasing CRR and SLR
3. Government bond purchases (OMOs) 3. Government bond sales (OMOs)
Impact on Banks lend more as the cost of borrowing is Banks lend less as the cost of borrowing
Bank reduced. increases.
Lending
Objective To boost aggregate demand, encourage To control overheating of the economy
in investment, and increase employment. and reduce excessive inflation.
Economy
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Impact of Inflation on Balance of Payments (BoP) in India
Aspect Impact of Explanation
Inflation on BoP
Current Trade Deficit Inflation increases the cost of imports (e.g., oil) and makes
Account Increases exports less competitive(due to higher prices), leading to a
higher trade deficit.
Exports Decline in Export As inflation raises the cost of production, Indian goods become
Competitiveness more expensive in international markets, leading to a drop in
exports.
Imports Increase in Inflation makes imported goods more expensive, especially oil
Import Costs and raw materials, causing a widening import bill and
worsening the trade deficit.
Currency Rupee Inflation weakens the rupee, making imports costlier and
Depreciation Depreciates increasing the current account deficit. A weaker rupee also
increases the cost of foreign debt.
Capital Flows Uncertain Capital Inflation uncertainty may cause foreign investors to pull out
Inflows money, reducing foreign investments (FDI, FPI). However,
higher interest rates due to inflation might attract short-term
foreign capital inflows.
Foreign Pressure on A higher import bill and weaker rupee mean India may need to
Exchange Reserves use its foreign exchange reserves to stabilize the currency,
Reserves depleting reserves.
External Debt Increased Debt Inflation causes the rupee to weaken, increasing the cost of
Burden repaying foreign debt (in foreign currency), making the debt more
expensive.
Economic Slowdown in Inflation can reduce consumer spending and increase costs,
Growth Growth leading to lower domestic investment and slower economic
growth, which can slightly reduce imports.
Interest Rates Short-Term Inflation leads to higher interest rates, which might attract
Capital Inflows short-term foreign capital seeking better returns, but could harm
domestic investment.
Overall BoP Worsening of The combined effect of high imports, low exports, currency
Impact BoP Deficit depreciation, and rising debt leads to a BoP deficit, requiring
borrowing or using reserves to balance it.
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Currency Depreciation, Appreciation, Devaluation, and Revaluation with Impacts
on different Economic Parameters
Aspect Currency Currency Devaluation Revaluation
Depreciation Appreciation
Definition A fall in the A rise in the value of a Deliberate reduction Deliberate increase in the
value of a currency relative to in the value of a value of a currency by the
currency others. currency by the government in a fixed
relative to government in a fixed exchange rate system.
others in the exchange rate
foreign system.
exchange
market.
Cause Inflation in the Higher demand for To correct trade To control inflation.
domestic domestic goods. imbalances. To reflect improved economic
economy. Increased foreign Boost exports. performance.
Lower investment. To attract foreign To stabilize the exchange rate.
interest rates. Trade surplus (e.g., investment.
Higher China’s trade surplus
current with the US).
account
deficits (e.g.,
India’s trade
deficit).
Impact on Exports Exports become Exports increase Exports decrease (less
Exports become expensive (reduces (more competitive). competitive).
cheaper(boost exports).
s exports).
Impact on Imports Imports become Imports become Imports become cheaper
Imports become cheaper (reduce more expensive (reduce costs).
costlier(inflati costs). (inflation risk).
on risk).
Impact on Foreign debt Foreign debt Increases foreign Decreases foreign debt
Debt becomes more becomes cheaper to debt burden if debt is burden if debt is in domestic
expensive due repay. in foreign currency. currency.
to currency
depreciation.
Impact on Inflation rises Inflation falls as Inflation rises due to Inflation falls as cheaper
Inflation as import cheaper imports reduce higher import prices imports ease cost pressures.
prices increase overall price levels. (especially fuels and
(especially for goods).
oil and raw
materials).
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Example India: In 2018, China: In 2020, Yuan China devalued the China gradually revalued the
the Indian appreciated due to Yuan in 2015 to boost Yuan in 2005 to reflect
Rupee strong export exports. growing economic strength.
depreciated to performance and FDI Sri Lanka devalued its Pakistan revalued its currency
₹74/USD due inflows. currency in 2019 to in 2001 to stabilize the
to rising oil address its balance of economy post-crisis.
prices and a payments crisis.
widening
trade deficit.
Government/I Depreciation Appreciation can Deliberate strategy to Revaluation is often used by
MF View can help reduce inflation but correct trade strong economies with a
correct trade harms exports and imbalance, but may trade surplus but can hurt
imbalances economic growth. cause inflation and export competitiveness.
but may lead currency volatility.
to inflation
and increased
foreign debt.
Exchange Floating Floating exchange Fixed exchange rate Fixed exchange rate system
Rate System exchange rate rate system (market system (government (government intervention).
system forces). intervention).
(market
forces).
Risks Inflation. Loss of export Inflation. Reduced export
Increased competitiveness. Reduced investor competitiveness.
foreign debt Capital outflows. confidence. Capital outflows.
burden.
Commonly Countries with Countries with floating Countries with fixed Countries with trade surpluses
Used By floating exchange rates (e.g., exchange rate and strong economic growth
exchange US, EU). systems in balance of (e.g., China, Pakistan).
rates (e.g., payments crisis (e.g.,
India). Sri Lanka, Zimbabwe).
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